Sorry — there simply is not a ‘magic formula’ or ‘magic multiple’ used in valuing businesses.
The reason that ‘one size fits all’ does not apply is that valuations vary industry by industry, geographic region by region, by size of the business, the type of business, from buyer to buyer and by a buyer’s perceptions of either or both the Risk or Opportunity involved. There are dozens of books on the topic and even when CPA’s take 6 or more different formulas and average them to arrive at a price it might be mathematically correct —- but very rarely will it have any relationship in the real world to the fair market value of the subject business.
Many people believe that a company’s revenues determine value — but if one company does $10 million a year and loses money is it logical that it is worth more than one doing $5 million and making a $1 million a year? What can be a good starting point is ROI — Return on Investment but first you need to be understand of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization and after management expense and after removing all Owner Perks). If EBITDA is expressed as a % of a given Purchase Price, you have what the ROI for that period of time if a Buyer had paid the Purchase Price in cash [i.e. no leverage]. Different buyers have different requirements and expectations when it comes to ROI — so while this starts to clarify the valuation picture it is just one of the key issues involved in valuations.
Among the other factors are the stability of margins, trend of revenues, any customer or vendor concentrations, expiring patents or contracts, environmental risks, technology changes within the industry and a number of other factors that can strongly influence a buyer’s expectation of ROI and therefore the value of a business.
With businesses with market values of less than $5 million a major factor affecting value, marketability and being able to achieve The Best Possible Transaction is whether or not the business and a given buyer can qualify for SBA guaranteed financing that can be the means to an all cash transaction with as low as a 10% to 20% buyer cash down payment.
The bottom line is that, in our opinion, the only people who can accurately provide you with a Fair Market Valuation of your business are those who are actively involved in and ‘know the market’. One caveat though is you should not pay for a valuation as there are a host of people who do ‘valuations for a fee’ and they have no real contact with the marketplace, just a series of textbook formulas. Many charge significant valuation and other front end fees, costs and retainers and collecting those monies is really their core business —- not the sale of businesses. In our case, we will provide you with a fair market valuation of your business without you incurring any cost or obligation — and in many cases those business owners then retain us to sell their businesses and because we don’t get paid a dime until the business is sold, we have no incentive to ‘tell you what you want to hear so you will pay a fee’ and thus we need to be very accurate in our valuation work. As you will see elsewhere on this website, when we take a business to market we do so without naming a price —- as we do run across buyers who are willing to pay more than what we believe a business is worth and if we named a price we would have ‘left money on the table’, which is an unpardonable sin!